Functions of Commercial Banks

The main functions of commercial banks are accepting deposits from the public and advancing them loans. However, besides these functions there are many other functions which these banks perform.

Paul Samuelson has defined the functions of the Commercial bank in the following words: “The Primary economic function of a commercial bank is to receive demand deposits and a honor cheques drawn upon them. A second important function is to lend money to local merchants farmers and industrialists.”

The major functions performed by the commercial banks are:

1. Accepting Deposits

This is one of the primary functions of commercial banks. The commercial banks accept different types of deposits, the deposits may be broadly classified as demand deposits and time deposits. The former refer to the deposits which are repayable by the banks on demand by the depositors, while the time deposits are accepted by the banks for a fixed period of time before the expiry of which they don’t return the deposit. The demand deposits include the current account deposits and savings bank account deposits. These two types of deposits earn very low rate of interest as they can be withdrawn any time. In the case of savings deposit, the depositor is not allowed to withdraw more than a fixed number of times or amount over a period of time. The time or term deposits include the fixed deposit and recurring deposits. In the former a sum is deposited for a fixed period of time determined at the time of deposit and is never allowed to be withdrawn before the expiry of period of deposit. Any such foreclosures will invite penalty apart from forfeiting the interest. Recurring deposits are the type of deposits in which a depositor agrees to deposit a fixed sum of amount every month for a number of months as determined in advance, and at the end of which the depositor will be repaid his deposit amount along with interest. Every bank will be interested in mobilizing as much deposit as possible as it would improve its liquidity with which the bank can meet is liabilities and expand its business.

2. Advancing of Loans

Commercial banks accept deposits and use them for expansion of their business. The banks never keep the deposits mobilized idle. After keeping some cash reserve, they invest the funds and earn. Commercial banks also lend loans and advances to the common men after satisfying themselves about the credit worthiness of the borrowers. They grant different types of loans like ordinary loans in which the banks lend money against collateral security. Cash credit is another type of loan in which the entire amount sanctioned is credited into the borrower’s account and he is permitted to withdraw only a specified sum at a time. Overdraft is yet another facility under which the customer is allowed to withdraw an amount subject to the ceiling fixed, from his account and he pays interest on the amount of overdrawn. Discounting bills of exchange is another type of advance granted by the commercial banks in which a genuine trade bill is discounted by the banks and the holder of the bill is given the amount and the banks arrange to collect the due from the drawer of the bill on the date of maturity.

3. Investment of Funds

One of the main functions of the commercial banks is to invest their funds so as learn interest and returns apart from utilizing their funds in a productive manner. In India as per the statutes, commercial banks must invest a part of their total investments in government securities and other approved securities so as to impart liquidity. Banks apart from enabling them to earn out of their investments, now a days have set up mutual funds through which they mobilize funds from the people invest them in very attractive projects which is a help rendered to the investors who otherwise will not have the benefit of participating in the project. Banks administer these mutual funds through specialists and experts whose services are not available to the common men.

4. Agency Functions of Commercial Banks

Commercial banks function as he agent of their customers and help them several ways. For these agency services, the banks charge a nominal amount. The agency services include, transfer of customer’s funds, collection of funds on behalf of the customers, transactions in the shares and securities for their customers, collection of dividends on shares and interest on debentures for their customers, payments of subscriptions, dues, bills, premia on behalf of the customers, acting as the Trustees and Executor of the customers, offering financial and other consultancy services, acting as correspondents of the customers, etc.

5. Purchase and Sale of Foreign Exchange

The commercial banks account for by far the largest proportion of all trading of both a commercial and speculative nature and operate within what is known as the interbank market. This is essentially a market composed solely of commercial and investments which buy and sell currencies from each other. Strict trading relationships exist between the member banks and lines of credit are established between these banks before they are permitted to trade. Commercial banks are a fundamental part of the foreign exchange market as they not only trade on their own behalf and for their customers, but also provide the channel through which all other participants must trade. They are in essence the principal sellers within the Forex market. One important thing to remember is that commercial and investment banks do not only trade on behalf of their customers, but also trade on their own behalf through proprietary desks, whose sole purpose is to make a profit for the bank. It should always be remembered that commercial banks have exceptional knowledge of the marketplace and the ability to monitor the activities of other participants such as the central banks, investment funds and hedge funds.

6. Financing Domestic and International Trade

This is a major function of the commercial banks. The international trade depends to a large extent on the financial and other support given by the banks. Apart from encouraging bills transactions, the banks also issue letter of credit facilitating the importers to conduct their trade smoothly. The banks also process all the documents through consultancy services and reduce the botheration of the traders. They also lend on the basis of commercial bills, warehouse receipts, etc., which help the traders to expand their business.

7. Creation of Credit

It is worth noting the credit created by the commercial banks. In the process of their lending operations they create credit. The process involves the following mechanism; whenever the banks lend loans, they do not pay cash to the be borrowers; instead they credit the accounts of the borrowers and allow them to withdraw from their accounts. This means every loan given will create a deposit for the banks. Since every deposit is equal to money, banks are said to be creating money in the form of credit. As a result the volume of funds required by the trade, government and the country is met by the banks without any necessity to use actual cash.

8. Other Functions

Other functions of commercial banks include providing safety vault facility for the customers, issuing traveller’s cheques acting as referees of their customers in times of need, compiling statistics and other valuable information, underwriting the issue of shares and debentures, honoring the bills drawn on them by their customers, providing consultancy services on financial and investment matters to customers, etc.

In the process of performing all the above mentioned services, the banks do play key role in the economic development and nation building. They help the country in achieving its socio-economic objectives. With the nationalization of banks, the priority sector and the needy people are provided with sufficient funds which helm them in establishing themselves. In this way the commercial banks provide a firm and durable foundation for the economic development of every country.